Case Game: The Case Of Accurate Costing

CASE GAME
The Case Of Accurate Costing
Contd.

THE DISCUSSION

P.K. GOTHI
MD, Morarjee Goculdas Spg & Wvg Co.

It is important for Abhinav Kumar to re-visit some fundamentals as far as cost management at Total Industries is concerned. Cost reduction should be an on-going exercise. It cannot be a piecemeal response to market-driven compulsions like price-reduction. When cost reduction becomes independent of the organisation's long-term strategy, people become disoriented. Everyone scurries to achieve short-term goals. That is a danger which Total Industries should guard against.

Kumar seems obsessed with the 'accuracy' of cost data. There is no such thing as accurate cost data. Given the two extremes of inaccurate data (which managers with a finger on the pulse of the business can sense right away) and precise data (for which no manager would have the patience to wait), one should take the middle path. The bottomline is clear. As long as the data at hand provides a dependable basis for a particular business judgment, it is okay.

No method of cost ascertaining and cost control can serve this purpose in isolation. You need a combination of approaches. This is particularly true of a multi-business, multi-product, and multi-channel organisation like Total Industries. Activity-Based Costing (ABC) can help measure the costs of business processes like sourcing, order fulfilment, servicing, and design. It can provide a link between spending and the effectiveness of the processes. Once Kumar decides to take up techniques like TQM or BPR, ABC can pin-point their impact on the effectiveness of the company's processes. And it can also track the cost of customised products. In contrast, in a mass production context, marginal costing helps make better decisions. The clincher: what does the management want to track? On that would depend the system of costing the company should adopt. There is a caveat, though: once you have tried and tested a particular costing system, let it be.

True, no costs are fixed. But, at the same time, no costs are completely variable either. There are several ''direct'' costs which do not move in proportion to the output. For instance, a plant has a capacity to produce 100 units, but produces only 80. The proportion of some of the direct costs-like power and water-does not fall in the same degree as the fall in output.

It is difficult to believe that ABC is not suited to a business which has a large proportion of direct costs. Kumar and his team should, in my view, look at the ABC technique seriously. It can isolate the costs associated with several non-value added processes whose impact on the total cost structure could be substantial for a company like Total.

The need to reduce costs should be balanced by improvements in the quality of customer service. The Balanced Scorecard will help Kumar focus on both the financial performance and the long-term strategy of Total. If the concept is driven down the line in the organisation, it will help in galvanising the team in the above direction and create satisfied stakeholders-be it customers, employees, vendors, or shareholders.

G.P. JAKHOTIYA
Prof. (Fin.), Jamnalal Bajaj Institute of Management Studies

Activity Based Costing is old wine in a new bottle. It is no more than good old Strategic Cost Management redefined. It is, essentially, a technical approach which helps convert most common costs into identifiable costs even while bypassing the arbitrary overhead allocation rates used in conventional cost accounting. But there ends the scope of ABC. Identifying costs according to activities and then driving them to the product through an appropriate cost-driver serves a limited purpose of activity-wise overhead cost accounting.

However, certain committed common costs (like risk-coverage costs) cannot be identified by activities even in ABC. Such costs are best treated by identifying their strategic purpose. Many compulsory costs, incurred at various stages of the life-cycle of a product, should, thus, be treated entrepreneurially. They cannot be treated with the theoretical sanctity of ABC. Of course, every division-head would like to know the correct cost of the products in his division.

This correctness of cost would, partially, be established by ABC. But Total's response to the market should depend on what may be called Objective-Based Costing (OBC). At the core of OBC are long-term sustainable corporate objectives and targets. Fixed costs can be altered by re-shaping the company's value-chain. The aim should be to achieve differing rates of return at different stages of the life-cycle of the organisation. You may have Time Return On Investment (ROI), Intellectual ROI, Physical ROI, Product, or Activity-wise ROI-depending on your key business constraints or strengths. These should decide cost-subsidisation between two products, processes, programmes, or places.

The four business divisions of Total Industries will have to define their value-chains, identify their investments, and then establish an equilibrium between profitability and investment. This equilibrium should define the trade-offs between operating and financial costs, and micro- and macro-costs. In a globalised scenario, such a matrix will have to be supported by two more dimensions: brand-building and employee quality.

A 360 degree look at cost performance is essential. A logical extension is that employees would be encouraged to look at costs entrepreneurially. This requires that each product division be treated as an investment centre, and each individual product become a profit-centre. Cost-reduction should also be based on continuous value-analysis.

R. SANKAR
Associate Director, Pricewaterhouse Coopers

Total Industries needs focus. Far from strengthening brand equity, an unwieldy product portfolio can weaken it by causing investments in brand building to be spread too thinly. Pruning the product portfolio will slash costs and release funds for fresh investments in existing businesses. Abhinav Kumar should, thus, re-evaluate his businesses.

Next, Total Industries should evaluate its business model in the light of the emerging New Economy. Kumar should set up a task-force to study and report on how Total can re-invent itself through infotech. Other task forces should be set up to focus on specific areas of cost under an enterprise-wide cost reduction programme.

Can Total re-configure its supply chain and use differential practices for different customer or distribution segments to cut costs and provide appropriate, rather than excessive, value?

Can Total eliminate the links in the supply chain that do not add value?

What synergies can it exploit in channel management and distribution?

How can Total lower its cost of reach without compromising on the levels of service?

Can the total cost of ownership be reduced through vendor-base rationalisation, supplier partnerships, and better planning?

Can waiting time be reduced at the factories by re-organising the layout of the plants, ensuring material availability, and machine up-time?

Can a cash management system be used to reduce money in the pipeline and to lower the organisation's interest cost?

The possibilities are endless, and the rewards, fabulous. But the success of the programme rests on the enthusiastic participation and support of employees at all levels. Rewards and recognition, the involvement and commitment of the company's top management, and a strong change-management programme in the organisation are the other ingredients of success.

A culture of cost-consciousness can be developed and sustained by example rather than precept and by making cost-effectiveness a critical measure of performance for the senior managers. Continuous benchmarking against industry leaders in India and abroad, and challenging employees to achieve impossible levels of cost and service are the other techniques that the company should consider.

It may be true that the proportion of overheads to the total cost of operations is low in Total's businesses. But the management should collect and review information relating to the company's total cost structure, not merely the cost of manufacturing operations. Given the businesses the company is in, product management, brand-building, and the forward supply chain are certain to consume large resources. In most companies, there is little analysis and less control over these costs.

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